WSJ: Zynga - Virtual Products, Real Profits

By IBT Staff Reporter On 09/09/11 AT 1:26 PM

While both Groupon and Zynga were proposed to be IPOs in the second half of 2011, it appears now Groupon might be hedging a bit and pushing out their IPO data due to the theatrics in the market. Have not heard such language from Zynga yet. The WSJ takes a look at this unique hypergrowth online video game maker; it is definitely a very unique business model versus say Electronic Arts (ERTS).

To understand why Zynga Inc. is among the tech industry's hottest companies, consider how it gets people to buy a bunch of things that don't exist. Last year, Zynga product managers for a videogame called FishVille discovered something intriguing while sifting data that Zynga collects when people play its online games. Players bought a translucent anglerfish at six times the rate of other sea creatures, using an imaginary currency people get by playing the game.The FishVille managers had artists whip up a set of similar imaginary sea creatures with translucent fins and other distinctive features, says Roger Dickey, a former Zynga general manager who left the San Francisco company recently. This time, they charged real money for the virtual fish, and players snapped them up at $3 to $4 each, says Mr. Dickey.

Zynga is transforming the game industry. Traditional videogame companies create games they think players will like, then sell them. Zynga offers free games through Facebook Inc.'s social network, then studies data on how its audience plays them. It uses its findings to fiddle with the games to get people to play longer, tell more Facebook friends about them and buy more virtual goods. At the heart of the whole process is Zynga's ability to analyze reams of data on how players are reacting to its games.

We're an analytics company masquerading as a games company, said Ken Rudin, a Zynga vice president in charge of its data-analysis team, in one of a series of interviews with Zynga executives prior to the company's July filing for an initial public offering.

Over 95% of Zynga's players never spend a nickel on its games. But its audience of 150 million unique monthly users is so large that the small percentage that buy $5 imaginary chickens in FarmVille and $3 imaginary skyscrapers in CityVille generate big bucks for the company. Some players spend hundreds or even thousands of dollars a month—they're called whales inside Zynga, the same term casinos use for high rollers.

Zynga's revenues rose to nearly $600 million last year from $121 million in 2009, according to the company's Securities and Exchange Commission filings for an IPO. While many tech upstarts are money pits, Zynga made a $91 million profit last year.

Recent stock-market turbulence has created uncertainty about IPOs and could force Zynga to delay and lower the valuation of its offering. When it filed for its IPO, the company was planning to seek a market value of as much as $20 billion, say people familiar with the matter. That would be nearly the combined value of veteran game publishers Activision Blizzard Inc. and Electronic Arts Inc.

Sales of traditional games are flat in the $10-billion-a-year videogame industry. And Zynga's success is attracting a wave of companies that develop free games supported by the sale of virtual goods. Walt Disney Co. and Electronic Arts both acquired Zynga rivals for hundreds of millions of dollars each. Electronic Arts launched a free Facebook version of The Sims, a top-selling traditional game, a few weeks ago. The game already has nearly eight million active daily players.

No one expects traditional games to disappear. But momentum is shifting. Total virtual goods sales in the U.S. are expected to jump 50% to $2.22 billion this year, while retail sales of games are likely to rise only 1% to $9.7 billion, estimates brokerage firm ThinkEquity.

Zynga's dependence on Facebook for nearly all of its revenue is also a potential liability. Last year, the social network cracked down on the ways in which companies like Zynga could send messages to Facebook members, many of whom had come to despise the come-ons to play various games as forms of spam. By the time of that change, Zynga had a large audience of players to whom it could promote future games in ways still permitted by Facebook.

By building its business on Facebook, Zynga has access to a deeper well of data about its users' online activities than ordinary websites do. When people install a game from Zynga or another Facebook developer, they give the companies permission to record their names, genders and lists of Facebook friends, among other information. Zynga can then use that information to figure out tactics to get people to invite friends to play its games, something a company with mostly anonymous players can't do.

Zynga executives respond that they design games to attract a broad audience, not just hard-core gamers that form the backbone of the traditional games business. In most of Zynga's games, players don't win by blasting away an opponent with a gun. Instead, they seek status and fulfillment by having the most abundant farms or well-developed cities. We're making mass-market entertainment everyone can play, says Brian Reynolds, Zynga's chief game designer and a veteran of traditional games companies.